With the debacle of the FTX cryptocurrency exchange, insolvent despite a third exchange status in the world, the issue of proof of reserves for all platforms is back on the table. Explanation.
The fall of the US empire FTX recorded in November is just a replica of the examples of Mt. Gox, the exchange founded by Frenchman Mark Karpelès, and Canadian platform QuadrigaCX, fell in 2014 and 2019 respectively, due to mismanagement and the use of fractional reserves. A method that consists of operating without keeping all customer deposits in reserve and oh so risky in the context of the undeniably volatile crypto market.
What is Proof of Reserves?
Proof of Reserves is an initiative that aims to increase the transparency of digital asset providers and ensure the correct presence of assets at a given address. As far back as 2014 and the bankruptcy of Mt. Gox, American columnist and tax expert Jason Tyra published on the concept of “Proof-of-reserves”, the need to require cryptocurrency platforms to meet this standard of transparency. In 2019, bitcoin startup Blockstream provides a technical methodology to popularize the practice. But it is mainly the analyst Nic Carter who regularly returns on social networks and in the press on this subject to propagate the concept to the most important stakeholders: the users.
It is necessary to distinguish the proof of reservations from the audit. An audit is a procedure performed by an entity to assess the compliance of a company’s accounts. But if a cryptocurrency exchange platform can be solvent or have a consistent balance sheet, this does not prevent it from using an individual’s deposit for a purpose that the latter has not authorized. Thus, the two procedures are compatible: the audit to check the solvency of a company, the proof of reserves, the proper use of user deposits.
How to perform a Proof of Reserves?
Proof of reserves is therefore supposed to enable each platform user to self-verify the presence of their assets at the deposit address, as if a bank customer were coming to verify the presence of an asset in their briefcase.
For this it is necessary to compare the data produced by the platforms with the information on the blockchain, the only reliable source. There are several methods: cryptography with the Merkle tree (a hash structure containing encrypted data), whose fingerprint must be compared to the platform’s measurements; building a transaction (not finalized) containing all of a platform’s unused bitcoins (UTXO); the simple creation of a list of reserves associated with public keys and compare them with the balances and addresses of the customers.
Which platforms provide proof of reservation?
The American platform Gate.io is one of the first to implement a proof of reserve tool, using the Merkle tree technique, followed by its counterpart Kraken. Since the FTX scandal, Binance, OKEX, Kucoin promised to use the same process.
Bitmex once used the same process, but now publishes an easy downloadable file for the customer to compare on-chain assets with the data published by the platform. As for the Blockstream process of the invalidated UTXO transaction, it is used by the Bitcoin Core and Trezor wallets.
And what about France?
In France, the StackinSat platform did not wait for the FTX disaster: last June it announced the launch of its proof of reserves system. For this it uses the services of a service provider, the Israeli Fireblocks. On the side of the Coinhouse and Paymium platforms, the procedures have not yet been put in place, but according to our information, they are each in the work phase on this subject.
Remember that to work on our soil, the PSAN status, issued by the AMF, is mandatory and requires an annual audit, even if, as we have seen, it does not constitute proof of reservation.